It’s time again. Much like the Olympics and the FIFA World Cup, it’s an epic event that comes once every four years. It is U.S. presidential election season. And now that Labor Day weekend is behind us with less than nine weeks remaining until Election Day on Tuesday, November 5, the focus and attention on politics and the markets is kicking into high gear. So what should we reasonably anticipate for the economy and markets as we move through the final weeks until Election Day and beyond?
Perspective. An important point is worth emphasizing before going any further with the discussion of presidential politics and its impact on the economy and financial markets. We’re going to hear a lot of hyperbolic rhetoric in the coming weeks from both sides of the political aisle about the implications on the economy and markets from who wins or loses the presidential election. But here’s the thing. The U.S. economy is a beast. It is absolutely huge and it’s going to do largely what it’s going to do regardless of who might or might not occupy the White House. It is so much bigger than any one person, even a person with the power of the presidency. And the same is true of the financial markets that reside within the U.S. economy. Can a president make differences on the margins of the economy – push things a little bit here, pull them a little bit there? Absolutely. But they can only do so much when it comes to the economy and markets. Instead, I would argue that the Chair of the U.S. Federal Reserve is FAR more influential in this regard than any person or party that sits behind the resolute desk.
Another point is equally important when considering the upcoming election. So much focus will be on the U.S. presidential contest, but it is only one of the three contests that matter at the end of the day. Also up for grabs on Election Day is control of the U.S. Senate and U.S. House of Representatives. What is being decided from an economic and markets perspective is what party is setting fiscal policy, which plays a role in influencing the economy and markets on the margins as indicated above. And the executive branch in the presidency can only execute the laws that have been legislated by the Senate and House. Put simply, the outcome of all three elections is more important from an economic and market perspective than any one outcome in isolation.
Gridlock. As we continue our descent toward analyzing the implications of the upcoming election, another key point merits discussion. When it comes to financial markets, what they hate most is uncertainty. Once investors know an outcome with certainty, they can model against it and invest accordingly. And this includes fiscal policy coming from the government. As a result, if the election result leads to gridlock where both parties win at least one of the three elections – presidency, Senate, House – the markets actually tend to like this outcome best. Why? Because it means that the U.S. government is less likely to do anything from a fiscal policy standpoint to which investors have to adjust. The more cynical among us might even put it that investors like split government in Washington because it means they won’t be able to do anything to screw things up for markets.
As a result, as we evaluate the potential outcomes of the upcoming election in early November that includes the U.S. presidency as well as the Senate and House, we will look at each in terms of what party is likely to win each contest and what that means in aggregate. Instead of getting into the policy weeds like what candidate says they’re going to be the one to put the proverbial soda machine in the lunchroom, we will focus simply on what the data is telling us as we draw closer to Election Day.
U.S. Senate. Of the three upcoming contests, the U.S. Senate contest arguably has the most certainty in terms of its outcome. The Democrats currently control the 100 seat U.S. Senate with 47 seats being held by the party along with the four independents that caucus with the Democrats (think Bernie Sanders (VT) and Joe Manchin (WV)) and the Vice President as the added tie breaking vote. In short, Democrats control the Senate with a 51+VP majority versus the GOP at 49 seats. In other words, they only have one seat to lose at most, and that assumes they are able to win re-election to the execute branch.
Looking forward, control appears likely to shift to the Republicans coming out of Election Day in November. Simply using one of many major election forecasting sources, the Decision Desk HQ and The Hill is predicting that the GOP has a 70% probability of taking control of the U.S. Senate. And I would contend that the probability in reality is actually even higher.
Why is the Senate outlook so challenging for the Democrats in November, particularly when they currently have the majority? It comes down to the reality of math. Given that senators serve 6 year terms, only one-third of the Senate comes up for re-election every two years. And when examining the 34 of 100 senate races that are up this cycle, 23 of these seats are currently held by Democrats or Independents versus only 11 for Republicans. Moreover, of the 23 seats that Democrats have to defend to keep their one plus VP majority in the Senate, eight are in states with an underlying electorate that currently leans Republican to varying degrees. For example, Bob Casey is the senator from Pennsylvania that is up for re-election this cycle in a state that ranks R+2 in the Cook Partisan Voting Index (PVI). By comparison, none of the 11 GOP seats up this cycle are in states with a Democratic leaning electorate.
Let’s look deeper at these eight states with Democratic senators and Republican leaning electorates. The good news for Democrats is that they are currently projected to continue to hold these seats in five out of the eight contests. Thus, control of the U.S. senate comes down to three particular contests.
The bad news for Democrats is that one of these three remaining seats is all but certain to flip to the Republicans, as retiring former Democratic and currently Independent senator Joe Manchin (there’s a reason he switched from Democrat to Independent in recent years) is exiting a seat in West Virginia that is now R+22 according to the Cook PVI. Current polling strongly favors the Republican candidate flipping this senate seat in November.
This brings us to the key race to watch as we enter into peak election season over the remaining nine weeks. Jon Tester is the Democratic senator from Montana that is up for re-election in a state that ranks R+11 on the Cook PVI. The race remains too close to call, but GOP candidate Tim Sheehy currently has 73% odds of flipping the seat come election day according to Decision Desk HQ. If Democrats lose this Montana senate race, the GOP will almost certainly control the U.S. Senate for the next two years.
But even if the Democrats prevail in Montana, they also need to win the third seat in this group in Ohio. Democratic incumbent Sherrod Brown currently leads in the polls and has a 62% probability of winning re-election.
So putting this all together, the key race to watch in determining what party is likely to control the U.S. Senate is Montana. Keeping an eye on Ohio as a second race is also worthwhile, but if Ohio starts to fall into the flip category, this likely means that Montana would have also moved further into the GOP category.
Presidency. What a difference two months make. If the election were held in early July, the probability for the GOP to retake control of the White House was very high. But since Vice President Harris replaced President Joe Biden at the top of the Democratic ticket, probabilities have shifted dramatically. Today, the Democrats now have a 56% probability of keeping the White House according to Decision Desk HQ, and VP Harris now leads in the aggregate popular vote polls by more than 3%.
Of course, as the 2000 and 2016 elections taught us (same with the 1876 and 1888 elections for those that remember back that far), the winner of the U.S. presidency need not win the popular vote, as instead it’s only the electoral vote that matters. It’s about who wins the most electoral votes from each state, and in this regard the race for the U.S. presidency remains too close to call.
As we start into peak election season, seven states warrant the most attention in deciding who will win the election. These are Arizona, Nevada, Georgia, North Carolina, Pennsylvania, Michigan, and Wisconsin. And when we break these states down even further, Trump is currently considered more likely to win in North Carolina, Georgia, and Arizona, while Harris is currently favored to win in Michigan, Nevada, Wisconsin, and Pennsylvania.
Put simply, the presidency remains fully up for grabs. And if we needed to pick one state above all others that is worth watching as we start into peak election season, it is Pennsylvania. More than any other state, whoever wins Pennsylvania gains a meaningful increase in their probability of winning the overall election. Thus, watching state polling out of PA is just as important if not more so than monitoring the national polls. Another state worth keeping at the top of the radar screen is Arizona, which is arguably the second most competitive state in the contest at present.
House. The race for control of the U.S. House of Representatives is arguably the most competitive of them all at present. The GOP maintains a razor thin majority heading into the next election, so it is the Democrats that are facing a marginally up hill battle as they need to pick up a handful of seats to regain control.
At present, the Republicans have a 56% probability of maintaining control of the House according to Decision Desk HQ. This is a race that we will likely revisit in more detail as we draw closer to Election Day. In the meantime, three particular House races warrant the closest attention in seeking to determine which party will have control come early November. These are California 13, Michigan 7, and Oregon 5. If either party is set to sweep these three races, it implies a meaningfully greater probability that they will control the House in the process.
Sweep. So let’s put this all together. We know the economy and markets like gridlock, but a sweep scenario can also be cheered by investors if it thinks its going to get policy prescriptions that are supportive of the markets. One has to look no further than the market reaction in the wake of the GOP sweep coming out of the 2016 election, as the promise of corporate tax cuts in a chronically low inflationary environment with a steady flow of liquidity from the U.S. Federal Reserve sent stocks flying to the upside for the next year afterward. Of course, markets could also scorn the potential policy subscriptions as well depending on what they may be.
Let’s take a look at the probabilities for each outcome. Based off of the Decision Desk HQ probabilities, we have a 76% probability for split government in Washington, thus the gridlock scenario where each party wins at least one of the three elections.
Of the remaining 24%, the GOP holds a 17% probability of a sweep win of the presidency, the Senate, and the House, while the Democrats have a scant 7% chance of pulling off the sweep. In other words, the GOP sweep scenario appears far more likely at this point than the Democratic three-fer.
With this in mind, it is worth considering the potential upside and primary downside risk associated with a GOP sweep in November since it is the more likely of the two outcomes.
Stocks may cheer a GOP sweep in 2024 the same way they did in 2016, as such an outcome would likely bring lower taxes and other market favorable legislative goodies over the next two years.
The potential also exists, however, that markets could recoil at such an outcome. Why? Because unlike 2016, we are still mired in an economy that is gradually making its way out of a scorching inflation problem over the last few years. While the headline and core inflation rates have come back to earth and inflation expectations remain in check, services inflation continues to run hot. And if we enter into an environment where a lot of fiscal policy stimulus is about to get poured in the economy that could reignite inflationary pressures, both stocks and bonds might start to rebel. The same could also be true if investors start to perceive that the independence of the U.S. Federal Reserve and their ability to heed the lessons of the 1970s comes under pressure where repeatedly cutting interest rates too soon and too aggressively caused even worse inflationary problems at the time. The first place to look to determine whether these risks start to worry investors will be the U.S. Treasury market and the direction of the 10-Year Treasury yield, as higher yields would be an early signal of such concerns.
Bottom line. Peak election season is now underway. And now that we have set the table, we will be monitoring the changing tides in the coming weeks between now and Election Day in working to determine how the outcome of each of the three key elections will impact fiscal policy expectations and the associated impact on the economy and financial markets. Even if these influences are only on the margins, they are still worth monitoring in understanding the policy backdrop for markets over the next two years.
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